New modelling from researchers at the Reserve Bank of Australia (RBA) found that supply and demand were not the main reasons behind the spike in house prices over the last decade, according to a study by Reserve Bank of Australia analyst. Instead, they said, the price boom was due to declining interest rates.

Housing prices have risen since the global financial crisis, and the increase was mostly found in Sydney and Melbourne, where median prices almost doubled in less than 10 years.

“We build an empirical model of the Australian housing market that quantifies interrelationships between construction, vacancies, rents and prices. We find that low interest rates — partly reflecting lower world long-term rates — explain much of the rapid growth in housing prices and construction over the past few years,” said Trent Saunders and Peter Tulip, researchers at the RBA, in a statement.

The model implied that the country’s dwelling-price-to-income ratio would have been significantly lower than where it is today, if not for the cut in interest rates.

In addition, the data suggested that more expensive prices and lower borrowing costs triggered the supply response from developers.

“The model estimates that the reduction in real interest rates (actual interest rates, less inflation) accounts for most of the subsequent boom in dwelling prices and a large part of the boom in dwelling investment,” Saunders and Tulip said.                                                            

The research also showed that the increase in housing supply lifted the vacancy rate and decreased rents, but these impacts were countered by the effect of higher income. This explains why neither the vacancy rate nor rents are substantially changed on net.

Apart from interest rates, faster population growth, brought about by increased immigration, has contributed to a higher dwelling-price-to-income ratio. The degree of impact, though, was not the same as the reduction in interest rates.

Australia’s unemployment rate has dropped to the lowest level since 2011, but the economy slowed significantly in the second half of 2018. Inflation is still below the RBA’s target by some margin, causing an increasing number of economists to believe the RBA will have to slash the cash rate again this year.